Great Mutual Funds on the Cheap

Faster than nearly anyone thought possible just a few months ago, Americans have jumped back into the market in a bid to rebound from the thrashing they took last year. And while good stock picking and smart bond selection are always important, savvy investors say one basic investment tenet is more vital than ever: Keep costs low.

When the stock market was logging double-digit gains year after year, most investors didn’t think twice about how much their mutual fund company charged them – and hardly made a peep if those expenses rose. But with investors still smarting from last year’s crash, even with the recent rebound, and experts cautioning not to expect a return to the old highs any time soon, the hunt for lower fees has become a crucial part of a sound investment strategy.

“The lower your fund cost, the faster you are likely to recoup the past year’s losses,” says Russel Kinnel, director of mutual fund research at Morningstar.

One of the ironies of the fund industry is that expenses often increase after a period of lousy performance, as companies make up for dwindling fund assets. It’s not surprising then that expenses are expected to reverse what has been a downward trend since 2003. Morningstar estimates that average fund fees could rise about 6 percent this year.

That might not seem like much, but costs can add up over time. Assume, for example, that a retiree has a $200,000 nest egg in one fund, growing 8 percent a year, and wants to withdraw 4 percent each year for the next 30 years. If the fund charges the industry’s average annual fee – about 1.5 percent – the retiree can withdraw about $9,600 a year. But with a fund earning the same return but charging only 0.2 percent, the retiree can withdraw $11,300 a year.

Of course, higher fees can be worth the price if they come with top-notch performance. “What’s important is how much the fund pays you in the end,” says Adam Bold, founder of the Mutual Fund Store, an investment advisory firm. At the same time, experts say that low fees often mean better long-term results.

The lowest-cost large-company stock funds, for example, returned an annualized average of 0.16 percent over the past decade, while the costliest lost 1.64 percent, according to fund researcher Lipper. The difference was even starker for small-company stock funds, with the cheapest returning an average 5.5 percent a year over the past decade, compared with a 1.6 percent return for the most expensive group.

Some experts believe that the financial crisis has convinced people to make lower-cost funds more of a priority. Vanguard reported inflows of more than $69 billion through August, with two-thirds of it going into its low-cost index-related products. Others are climbing onto the low-cost bandwagon. Putnam Investments lowered fees on some funds and linked other funds’ expenses to performance. Charles Schwab has cut fees on a range of funds, including many index products.

Some firms charge much lower fees to customers with, say, $100,000 to invest, but individuals also can choose a financial planner who pools together clients’ money to snag the lower costs. Morningstar’s Kinnel says, in general, just picking funds with the lowest expenses builds in a margin of safety: “Even if they raise their fees a bit, they are still among the cheapest.”